(Bloomberg) — The earnings outlook for companies in the S&P 500 Index is rapidly deteriorating — but analysts haven’t been able to raise their stock price targets fast enough.
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Think of it as the stock market disconnect in 2023.
The two seemingly incompatible trends reflect the extent to which stock prices are being dominated by speculation that the Federal Reserve is nearing the end of its most aggressive interest rate hike in decades. That bodes well for the valuation of growth and technology stocks, which have held on to big gains this week even after disappointing earnings reports from Apple Inc., Alphabet Inc. and Amazon.com Inc.
However, the extent to which analysts raised their stock price targets while slashing earnings estimates is baffling to those who used to see the market around the underlying strength of US companies.
“The interest rate has decreased and your discount rate has decreased, so even though your income has not increased, you can fix a higher price [on the stock] just because of the lower discount rate,” said Crit Thomas, global market strategist at Touchstone Investments. “They’re saying, ‘Hey, we’re going to get out of this in six to 12 months, so let’s take a look at it.”
The fourth-quarter reporting season did little to support the optimism about fundamentals. Earnings in sectors ranging from energy to consumer discretionary have been below pre-season estimates, and companies are reducing their outlooks on expectations growth will slow. In fact, Bloomberg Intelligence’s modeling shows that such earnings guidance in the first quarter has been cut by the most since at least 2010.
That forces analysts to stick to more optimistic estimates. Of all the changes analysts made to their earnings forecasts last month, only 37% were upgrades, data compiled by Citigroup Inc. synthesis shows. This level is related to the past three recessions and is 30% below the historical average.
“To us, analysts’ numbers for 2023 look too aggressive,” said Drew Pettit, director of ETF strategy and analysis at Citigroup. They were “quickly modified to better fit economic realities.”
There is still considerable uncertainty about the direction of the economy, especially with Friday’s rapid increase in job numbers suggesting it is still expanding at a solid pace. Overall, however, economists expect growth to slow or even contract as a result of tighter financial conditions.
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“We are starting to see some of these companies launch and give less-than-ideal guidance on growth,” said Brian Jankowski, senior investment analyst at Fort Pitt Capital Group. “We are starting to see business forecasts for growth that are more in line with GDP, which is expected to be very little sideways.”
That has largely been brushed aside in the stock market by speculation that interest rates are nearing a cycle top, a view that was supported by the Fed’s decision Wednesday to slow the pace of movement. its transfer. Sell-side analysts who track S&P 500 companies — and are already heavily bullish — responded by raising their stock price estimates at the fastest pace since spring 2021. .
The Fed’s central role in the stock price outlook is underlined by how well the market performed this week in the face of some negative earnings surprises from big companies.
Apple reported a bigger drop in holiday sales than Wall Street expected, while Ford Motor Co. announced a loss in profit in the context of continued shortage of supply. The results of Alphabet, Google’s parent company, signal lower demand for its search ads during a time of a slowing economy.
On Friday, however, the major stock indexes were little changed for most of the day before closing lower. Even so, the S&P 500 posted a second straight weekly gain.
Elsewhere in corporate earnings:
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